Profit is the quantity firms try to maximize. It is the difference between the firm's revenue and the cost of production.
Profit is an important measure in economics because a firm's goal to maximize profit is central to many economic models of production and supply. Simply put, profit is the amount left over from total revenue once total cost (however defined) is subtracted. Total revenue is the amount received by producers when selling output. For example, consider the overall profit for a manufacturer that produces furniture. The manufacturer may have high revenues, but they must pay for workers' salaries, materials, a space to create the furniture, people to sell the furniture, and ways to spread the word about their product. All of these are taken away from the total revenue (the money from furniture sold) to calculate the profit for the manufacturer.
In mathematical terms,
, where TR is total revenue and TC is total cost. In the example of the furniture manufacturer, the profit would equal the amount spent on the wood and employees' salaries taken away from the money earned by selling the furniture.
Total revenue is equal to the money that comes in from selling goods and services. In the simplest case, if a producer sells all of its output at the same price (P), then total revenue is equal to P times Q, where Q is the quantity of output produced and sold.
For example, if a company sells 50 units of output (Q) at $6 each (P), then total revenue is equal to $6 × 50, or $300. If the producer's output
is sold at various prices, total revenue can be calculated by multiplying each price by the quantity sold at that price point and then adding these numbers together to get the total revenue. If the same company in the above example sells 30 units of output at $6 each, but discounts the remaining 20 units of output and sells them at $5 each, then total revenue is equal to:
Once total revenue is considered, costs must be calculated to see the bigger picture. A company with a revenue stream of $300,000 per month suggests the business is successful. But if the business must spend $350,000 per month on expenses, it is in fact losing $50,000 every month.
Profit is essential to measure the success of a business. It provides a fuller picture than either total revenue or total cost. Profit can also be calculated on a per-unit basis by:
In this calculation, P is price, ATC is average total cost, and Q is quantity. For example, a company makes pillows and sells each pillow for $19. The average total cost to make a pillow is $5. The company sells 2,000 pillows. The profit is calculated as:
Profit=(Price of Pillows−Average Total Cost)×Number of Pillows Sold=($19−$5)×2,000=$14×2,000=$28,000
Using this calculation, the profit is $28,000.